Operations, Information and Decisions Papers

Document Type

Journal Article

Date of this Version

9-2014

Publication Source

Management Science

Volume

60

Issue

9

Start Page

2291

Last Page

2307

DOI

10.1287/mnsc.2013.1890

Abstract

This paper formulates and solves the selection problem for a portfolio of credit swaps. The problem is cast as a goal program that entails a constrained optimization of preference-weighted moments of the portfolio value at the investment horizon. The portfolio value takes account of the exact timing of protection premium and default loss payments, as well as any mark-to-market profits and losses realized at the horizon. The constraints address collateral and solvency requirements, initial capital, position limits, and other trading constraints that credit swap investors often face in practice. The multimoment formulation accommodates the complex distribution of the portfolio value, which is a nested expectation under risk-neutral and actual probabilities. It also generates computational tractability. Numerical results illustrate the features of optimal portfolios. In particular, we find that credit swap investment constraints can have a significant impact on optimal portfolios, even for simple investment objectives. Our problem formulation and solution approach extend to corporate bond portfolios and mixed portfolios of corporate bonds and credit derivatives.

Keywords

finance, investments, portfolio optimization, credit swaps

Share

COinS
 

Date Posted: 27 November 2017

This document has been peer reviewed.